I received a question last week from someone who wants to know if it is a good idea to withdraw money from their 401(k) plan to pay off debt. A question like this is always best taken on a case by case basis – so let’s see what we have.
Hello Patrick,
My husband is putting in the max matched at his company 401k. Last year he pulled most of that ($34,000) and put it into a Traditional IRA. He put the IRA in a 7 month CD because he’s thinking about pulling $20,000 from it in July to pay off his truck and rolling the balance into a Roth IRA. He will continue to contribute to his 401k until he retires in another year. This is our plan at this point — what would you advise?
Thanks, K.
Hello, K, Thanks for contacting us.
First, I think your husband is doing the right thing by maximizing his contributions to meet the company match on his 401k. It’s always a good thing to take advantage of free money, which is what the company match is. But retirement accounts should never be interchanged with savings accounts or used for short term goals. Retirement accounts work best when used for one thing – retirement!
The government gives very nice tax deferral benefits for 401k plans and Traditional IRAs, and a different but just as valuable long term investment benefit for contributing to a Roth IRA. In exchange for giving you these benefits, the government places strict penalties for early withdrawals from retirement accounts – a 10% penalty right off the top, plus the immediate payment of taxes on the earnings (assuming the age requirement of 59 ½ is not met).
The information in your question is limited, so if the penalties do not apply because you have met the minimum age limits to withdraw the money, then you won’t have to worry about the early withdrawal penalties. But you will still need to worry about taxes which will be due upon withdrawal. My other concern is whether or not you have enough money put away for retirement. I recommend taking a strong look at your retirement plan and whether or not your finances will be enough to support you in retirement.
Pinyo from Moolanomy:
I don’t know your situation fully so it’s hard to give you a specific answer, but here are a few things to consider.
First, is your husband old enough to withdraw fund from traditional IRA without having to pay the 10% early withdrawal penalty? If he’s younger than 59 1/2 at the time of withdrawal, he will have to pay 10% penalty on top of the taxes on the $20,000. Probably something you want to avoid.
Second, aside from the 401k, will you have enough income during your retirement? $34,000 is not a lot of money and you may want to hold on to the money to cover your retirement expenses.
Third, do you have an emergency fund in place? If you don’t have one already you may want to consider keeping the $34,000 or the remaining $14,000 as your emergency fund. A good place to keep this fund is in an online savings account due to the liquidity and still decent interest rates.
Whatever you decided to do, good luck. And thank you for asking the M-network.
Plonkee from Plonkee Money:
There are serious penalties for withdrawing money from tax advantaged accounts. Unless you’re faced with serious financial problems such as imminent bankruptcy that effects your employment or similar, I’d suggest that withdrawing money from an IRA is a not a good idea.
I’m unsure that you are going to have enough money to retire on. If you withdraw money to pay off the balance on the truck, that’ll leave you in the region of $15k plus social security (unless I’m missing something). The income you can generate from $15k for an extended period of time is around $50 a month. Have you had an estimate from the Social Security website to see what you are likely to qualify for?
Thanks for contacting us, K., and I wish you and your husband the best in your retirement plans.
What do you want to ask the M-Network? If you would like to participate in the “Ask the M-Network” feature, please send me a question via my contact page and I will submit it to our group. I’d like to remind you that it may not be possible to answer every question and none of use are financial professionals, so please consult with a professional before making any major financial decisions!
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I would not withdraw retirement funds for any but the most drastic situations. Just treat that money as unavailable. It is too easy to get in the habit of tapping that money and ruining retirement plans.
I can’t help but focus on the idea that this cat is trying to retire on $34,000. Maybe all his debt is gone ( except the car ) and he lives on cat food…. but unless that’s the case… $34k ain’t gonna take you very far. Perhaps we need to re-look at the entire financial picture before we worry about using nearly all our retirement savings to pay off a car.
That could be, Rob, but we don’t know the full picture of their retirement plans. They may own several rental properties or have a huge dividend stock fund or have some other source of income. Outside of their truck, they may not have any other bills. So it depends on their full situation. So, yeah, a look at their entire financial picture is the first thing to consider.
I’ve experienced those early withdrawal penalties, and they weren’t happiness.
I only recently learned that for a Roth IRA you can take out contributed principal with no penalties as long as your account is 5 years old. Gotta’ love Roth IRAs.
Using retirement accounts for anything but retirement is usually not a very good idea. Also having only 34K for retirement is going to work very well either so it may make sense.
I withdrew 10K from my traditional IRA last Feb (2008) to combine with my emergency fund to pay off my mortgage, whose P&I payments were $700.00 per month. I only needed 9K and I paid the 10% penalty upon withdrawal ($1000).
Since I had 100% stocks with this IRA, it lost about 50% of it’s value in the slump we are now in. Had I not withdrew the money, I would have lost it anyway, and still had the P&I portion of my mortgage. Now I have an extra 700 per month to invest. I think that is an excellant use of IRA money.
DC Reeves: Hindsight being 20/20, it worked out perfectly well for you, but not many people can predict the ups and downs of the stock market like that. Most of the time, early withdrawals are not worth it.
As for the extra $700 per month to invest, that’s a good way to look at it – but you would still be down a couple grand on your retirement savings. I hope you have time to build it back up.